Give Your Portfolio the Royal Treatment

 | Sep 25, 2012 | 9:45 AM EDT  | Comments
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Here at Insider Monkey, we like tracking smaller hedge funds that generally invest in small- and mid-cap stocks. Smaller hedge funds are more successful at uncovering hidden gems, and they usually deliver better returns. Royal Capital Management was co-founded by current managers Yale Fergang -- a Columbia and Harvard alum -- and Robert Medway, who served as a director at Master Replicas from 2004 to 2006. Royal Capital employs a long/short strategy, particularly focusing on bargain-priced small-cap and mid-cap stocks.

Below, we'll review the mid-cap holdings of this portfolio as reported in Royal's 13F regulatory filings with the SEC (You can see the entire portfolio here). The following companies are the four largest holdings in the fund's portfolio, by value, according to the fund's 13F.

Fidelity National Financial (FNF): Shares are up 31% year to date and, since 2009, this stock has performed particularly well for a financial name. The company provides diversified financial services, particularly in mortgage services and title services. Shares are trading at 14x forward earnings, which has been the upper limit of the share's valuation over the past two years. Thus far in 2012, the company has seen top- and bottom-line growth: Earnings for the second quarter came in at $0.65 per share, nearly doubling last year's earnings of $0.36, and revenue increased to $1.74 billion from $1.33 billion a year earlier. Further, the company has a manageable debt-to-equity ratio of 25, and it maintains an attractive 2.7% annual dividend yield.

WellPoint (WLP): Through its subsidiaries, this company manages health benefits for 65.3 million individuals in the U.S. The stock's forward price-to-earnings ratio of 8x (on 2012 earnings) lies at the lower end of its peer group, likely due to the stock's sluggish price performance as of late. About 84% of Americans have health insurance, and the number will likely continue to rise if the Patient Protection and Affordable Care Act ("Obamacare") remains on the books. According to Standard & Poor's estimates, revenue for 2012 will rise to $61 billion, up from $60.7 billion in 2011. The company has strong cash flow and operates at a sufficient scale to make it an attractive value investment at present price levels. Compared with Cigna (CI) and Aetna (AET), WellPoint is underpriced based on its EV/EBITDA ratio, or enterprise value to earnings before interest, taxes, depreciation and amortization, though its profit margin of 4% is a full percentage point below that of Cigna and Aetna.

HollyFrontier (HFC) was raised to Outperform from Market Perform by Wells Fargo this month, and this comes amid downgrades for its fellow refiners -- in particular, Phillips 66 (PSX). As we noted elsewhere, independent refiners respond well to low oil prices, even if demand is lagging. Shares of HollyFrontier are up 26% over the past three months, compared with a 9% gain for the S&P 500. A significant highlight for the company is its $1.18 billion free cash flow in 2011, which is up from $251 million in 2010 and a historical high. The company has lightened its debt structure to 23% debt-to-equity, down from more than 100% for the past several years.

L-3 Communications (LLL) is a technology contractor that provides a number of security and intelligence solutions, in particular for the U.S. government. Recently, the company won a preliminary $245 million contract from the Transportation Security Administration for its imaging system contracts. Deutsche Bank slightly decreased L-3 Communications' price target to $83 due to company's debt reduction ambitions and more conservative share-repurchasing and revenue levels for 2013. With a forward P/E of 8.8x, shares are not terribly expensive within the technology peer group, and the 2.8% annual dividend is also an enticing feature of this technology contractor.

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